Robert J. Samuelson commentary: Appointment to lead Fed is long overdue

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Monday August 26, 2013 5:48 AM

Was this necessary?

The struggle to succeed Ben Bernanke as chairman of the Federal Reserve has turned into a soap
opera. Bernanke, it is widely assumed, has told President Barack Obama that he doesn’t want a third
four-year term — or has been informed that he won’t be reappointed. This has triggered a highly
public campaign by partisans of the two leading contenders for the job: Lawrence Summers,
ex-treasury secretary (in the Clinton years) and former Harvard president; and Janet Yellen, the
Fed’s present vice chairman. Both are economists.

Summers, say his fans in op-ed articles and anonymous quotes, is “brilliant” and an experienced
crisis manager. (He helped defuse the 1997-98 Asian financial crisis and, as a top Obama aide in
2009, dealt with the Great Recession.) Yellen’s supporters counter that she was an early prophet of
the housing crisis and is a consensus-builder and an articulate communicator. She also would be the
first woman to head the Fed. Inevitably, each campaign questions the other candidate’s
qualifications. Summers is accused of arrogance; Yellen is seen as soft on inflation.

All this could have been avoided, or minimized, if the president had made his choice in early
summer. The result is that whoever wins will need to overcome the doubts and ill will created by
Obama’s indecision. This is an extra headache to go with many others, because today’s Fed is very
different from the one Bernanke inherited from Alan Greenspan.

Under Greenspan, from the summer of 1987 to early 2006, the Fed seemed almost omnipotent. Small
tweaks up or down in interest rates could, it appeared, sustain economic expansion and contain
inflation. During this period, job creation topped 30 million. The two recessions, those of 1990-91
and 2001, were mild. Stocks rose more than fourfold. The Fed became more popular. In his
confirmation hearings, Bernanke was emphatic: I will continue Greenspan’s policies.

History dictated otherwise. With hindsight, Greenspan’s apparent success in stabilizing the
economy fostered the financial crisis. Bankers, consumers and companies became overconfident and
complacent; they took risks that seemed justifiable but were ultimately disastrous. In the Bernanke
era, the Fed’s limited powers have become obvious. To be sure, Bernanke’s deft interventions in
2008 and 2009 probably prevented another Great Depression. But the Fed has had less success in
stimulating a strong recovery, despite keeping short-term interest rates near zero since late 2008
and trying to depress long-term rates by buying about $2.8 trillion of Treasury and mortgage
bonds.

Bernanke has been an avowed experimenter; bond-buying has been his big experiment. It’s an
understandable gambit to reduce suffering, and in some ways, it has changed behavior. A decade ago,
it was unimaginable that the Fed would openly try to “talk up” the stock market; now, that’s
routine because one goal of the bond-buying (referred to as “quantitative easing” or QE) is to
encourage more stock purchases by lowering interest rates on bonds, a competing investment.

Still, the economic effect has been modest at best. Slightly lower interest rates didn’t cause a
burst of production and job creation. Indeed, a study from the Federal Reserve Bank of San
Francisco estimated that the second round of QE added only 0.13 percentage points to economic
growth. (Other studies show larger effects.) Even these benefits might be reversed if the
bond-buying slows or stops. When Bernanke announced a possible cut in purchases to begin later this
year, interest rates shot up — exactly the opposite of what the Fed wants. Good intentions do not
guarantee good outcomes.

The next chairman faces political and economic challenges. Because the economy is doing poorly,
the Fed is not popular. It’s blamed for creating the crisis, aiding Wall Street and being too
powerful. There is no relief from this resentment until the economy improves, but the next chairman
needs to prevent the discontent from worsening. Down that road lie many bad ideas Congress might
foist on the Fed, starting with compulsory credit allocation: the funneling of loans to politically
connected industries. The Fed’s must deliver what it promises and respond competently to the
unexpected. This includes keeping an eye on inflation.

Being Fed chairman requires economic smarts, financial knowledge, political instincts and
communications skills. Summers and Yellen each has strengths, but neither has a clear advantage
over the other. It’s a judgment call — and Obama should make it sooner rather than later. The
longer the uncertainty continues, the greater the damage.